114 Your Pension Just Got Better

Unfortunately this week we don't have a Tommy Boy clip to weave in to the Financial Procast, so you'll have to be entertained or at least mildly amuse by our “normal” sense of humor. Today instead we figured we talk about pensions.

Less so pensions in particular and more so that the AARP recently published a hack piece on pensions and scaring retirees who have pensions that are being sold to private insurance companies. Should we really be that shocked?

In there June/July 2014 issue, includes an article (actually cover article) that's titled “How safe is your pension”. So, you'd think with that sort of title they'd be discussing various funding issues that pension funds are having or some other issues of significant substance

But let's not talk about the problems with your pension

That's not what they decided to discuss at all. Instead, they are talking about some bits of legislation that changed the rules a couple of years ago that allows companies to place pension obligations in a single premium immediate annuity that creates an income stream identical to the payment they were receiving under the pension. So, people will get the same amount of money they've been promised or that they were already receiving (if they were already being paid a pension benefit). No change in their benefits at all.

It's just now the check will come Prudential or any number of other insurance companies rather than Verizon or General Motors or whatever is the company in question. It's not only Prudential, that's just the company that was named in the article.

What's weird is that this is not a new phenomenon in the pension world. Municipal governments and other public plans have been doing this sort of thing for years.

One of the fear-mongering tactics of this article is that once the liability is shifted from the pension itself to an annuity, the benefit is not insured by the Pension Benefit Guaranty Corporation (PBGC). The PBGC does not cover public pensions but does insure private pensions.

However, if you think that rolling money into an insurance company as it relates to solvency, you should try to work with a pension benefit that's in receivership with the PBGC and see how much of a glorious retirement you'll be afforded. It's no walk in the park.

Ultimately the cost of administering pensions of these old plans with promises made long ago is extremely high. And so, to remove that expense from a company's balance sheet is take the benefit from an entity that's not interested in administering the benefit (GM, Verizon et al) and giving it to an insurance company that specializes in this who's been doing this for years without issue.

The company that's responsible for the benefit is able to purchase the income stream for retirees at a discount to what it would probably cost them to administer the benefit themselves.

These benefits are not “off the shelf”

We should have mentioned this in the beginning, but now's as good a time as any to let you know that we are insurance brokers and we have sold single premium immediate annuities. However, the type of annuity that is being purchased by GM or Verizon as it is discussed in the AARP article is not the same product that any retail agent/broker like us has access to. In fact, most of the time these are institutional level products that are specially created for this particular situation by the insurance company.

The calculations are done very specifically for the plan in question.

In fact, there have been times when we have worked with people who had options when it came to there pension benefits. They were offered the ability to roll out all of their money in a lump sum or to roll it into an annuity with whatever company their employer had used for providing periodic pension benefits. We've compared rolling the money out and buying a SPIA in the retail market with the benefit they would receive from the insurance company that worked in conjunction with their plan and never seen a retail product win.

In other words, no sales for us, but our client prevails because they are able to get a greater monthly benefit, so good for them.

If you only have access to retail products, then that's what you should use as those would be the next best thing.

Don't you think the AARP has responsibility to NOT do this sort of thing? The circulation of the magazine has to be huge–whether or not anyone actually reads it is another discussion for another day.

But you would think that they would want to provide information that doesn't do their audience harm. That's probably assuming a bit too much.

They do discuss the potential danger of taking a lump sum distribution from your pension plan. There is more than handful of vultures in the financial services business that would love nothing more than to tell everyone to roll out all of their money, all of the time and plow it into annuities and/or mutual funds. And that would be the wrong thing to do.

However, the AARP suggests that this is always the wrong thing to do. We don't think so.

Yes, in many circumstances it is not the best thing for a retiree to do but there are exceptions to that and we think an organization that's viewed by the audience it serves as being an authority has to tread very lightly on making absolute statements.

The bright light from Michigan

There was a bright light in this article. And that was a gentleman from Michigan, Mr. Schwaller, 84, who retired from GM and discusses the fact that he liked the idea of now receiving his pension payout from Prudential. He says he was “ready to dance with joy” when he heard the news.

One can only assume that he feels a bit more secure having Prudential on the hook for his benefit than GM. Who could blame him? General Motors has a history of not being able to meet obligations that it made to its retirees.

Let's take a closer look at the problem with the institution of pensions themselves. And please understand that this is a tangential discussion and that we are not in any way picking on Mr. Schwaller, we're just using him as a mathematical example.

The article notes that he is 84 and he retired in 1985. He would have been 55-56 when he retired, that means he's been retired for about 28 years. We don't know exactly when he started working for General Motors but let's assume that he started working at age 20.

That would have been around 1950 or so. He worked for about 35 years and has now been retired for 28 years. So, that means he doesn't have to live much longer to have been retired for longer than he worked. His life expectancy when started working was probably mid to late 60's–he's already exceeded his life expectancy by about 20 years.

All the assumptions for his pension benefits were calculated around that life expectancy. Hopefully you're all starting to connect the dots to the problem with the math here.

The truth about the economics

There is certainly a peace of mind to having a large, well-funded, and highly reserved company like Prudential on the hook for your pension benefits. And the truth is that most private pension plans are broke because they were grossly underfunded for extended periods of time not because the benefits were too rich.

The reality is that General Motors, for example, is in the manufacturing and assembly business, they are not in the business of designing and manufacturing financial products. GM will always have to balance where they allocate funds and the return on equity of building cars will always be their best use of money. The pension is just a drain on resources. By shifting that risk to a company like Prudential, they have done their retirees a favor.

Brantley is a practicing life insurance agent and has been for nearly 18 years. After years of trying to sell like his sales managers wanted him to, he discovered that people want to buy life insurance if you actually explain the benefits.